Verizon: Deutsche Ups to Buy on Smartphone, LTE Promise

By Tiernan Ray

Shares of Verizon Communications (VZ) today closed up $1.11, or 2.3%, at $50.01, after Deutsche Bank‘s Brett Feldman today raised his rating on the stock to Buy from Hold, and raised his price target to $56 from $49, a day after the company beat Q3 revenue and earnings expectations on an 8% rise in wireless services revenue.

Feldman writes that although the report highlighted continued strength in wireless, “We expect competition to pick up, but our analysis suggests that this threat is substantially offset by untapped revenue potential within VZ’s existing sub base.”

Feldman thinks the main focus should not be the battle for market share, but rather up-selling Verizon’s base to from feature phones to smartphones:

As of 3Q13, 67% of VZ’s post paid phone subs owned smartphones. This means that 33% still own feature phones. The carrier’s smartphone penetration rate has been climbing by roughly 3% per quarter, which implies that this trend should continue for another ~10 quarters. We believe that this trend is by far the most important driver of projected wireless service revenue growth over the next 2-3 years. This is because we believe that smartphone subs continue to generate roughly 2x the ARPU of feature phone subs due to the additional data charges. To put some numbers around this, VZ currently has 27.6M post paid feature phone subs paying the carrier something like $35-$40 per month (~$13B per year). If all of these customers eventually move to smartphones, which we believe have ARPUs in the range of $75, then this equates to an additional $12B of annual service revenue. In other words, VZ can potentially boost its total service revenues by 17% (vs. the annual 3Q13 run-rate) simply by getting smartphones into the hands of its current feature phone customers. To put this in perspective, VZ would have to lose over 13M smartphone customers during this same time period in order to offset the revenue uplift from this device migration. Of course, for this to happen it would first have to stop adding phone subs, which it is currently doing at a pace of ~400k per quarter. In our view, this quick analysis highlights why the potential for a somewhat more competitive market is not likely to materially disrupt VZ’s wireless revenue trajectory.

That might allow Verizon to sell more lucrative broadband wireless services of the “long-term evolution,” or LTE, variety:

Data usage is likely to continue to growing rapidly as VZ increases LTE device penetration. As of 3Q13, only 38% of VZ’s post paid subs had an LTE device, which is up more than 2x from a year ago. But, these devices are driving 64% of VZ’s total data traffic. In other words, LTE devices are datahogs. In the past, this would have been problematic as VZ originally only sold data via unlimited plans. But, the carrier is rapidly moving its customers to a usage-based pricing model. For example, as of 3Q13 42% of post paid accounts were on a Share Everything Plan. Under these plans, the more data you use, the more you pay (by purchasing larger buckets of GBs). So, as penetration of LTE devices grows over the next few years, data traffic is likely to grow even more quickly. Because revenue growth is now tied more directly to usage growth, this dynamic should provide VZ with a solid revenue tailwind that once again is driven more by the behavior of existing subs and not by market share gains or losses.

Feldman thinks the stock’s P/E multiple looks “attractive” relative to the average following the 2008 recession:

As shown in Figure 4, VZ’s current forward year P/E multiple (‘14E) of 13.7x is roughly in-line with its 12-year historical average of 13.4x. But, we believe the carrier’s post recession trading levels are a better benchmark since this period better represents the operating performance of its current asset mix (i.e. broadband wireless and wireline networks). On this basis, the current multiple looks attractive for 2 reasons. First, it is below its post recession average of 14.6x. Second, the stock has lost half of its historical premium vs. T; typically VZ trades at an average 2x premium whereas it currently trades just 1x higher.

Feldman trimmed his revenue and Ebitda estimates for this year to $120.36 billion and $41.87 billion from a prior $121 billion and $41.96 billion. His EPS estimate goes up 3 cents to $2.70.

For 2014, his estimate goes to $125.4 billion in revenue from a prior $126.8 billion, his Ebitda estimate rises to $45 billion from $44.7 billion. His EPS estimate rises to $3.57 from $3.54.

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OCTOBER 18, 2013 11:00 P.M.

Anonymous wrote:

Since Verizon decided to buy itself from Vodaphone and thus turned its back on entering the Canadian market even after being privately courted by Canada 's federal government: Guess what? Don't stop there. Use a Trojan horse. Get behind a foreign entrant or push for revisions to the CRTC and wireless code. The CBC's Lang and O'Leary Report reported on the Lance Armstrong conspiracy. They may very well have to interview people re the state of idiocy and business in Canada is now everything has a problem and it's all about mental health. Nonsense. Yesterday's Bokshevik is pushing today's Mental Health Industrial Complex. And they're using BCE that's going around buying up everything in sight because the CRTC allows it in the name of culture. What culture? Minority politics? Supporting idiots who think church and state should be one and the same? No wonder. Last year China invested $93 billion in Canada's oil and natural gas investments along with mergers and acquisitions. This year. China tossed in $10 billion. 10 versus 93. Hmm. You think the milieu around BCE helps or impresses foreign investors like Verizon, China or whomever or whatever? Ha. Nobody wants to deal with irrational and childish nuts full of themselves and their message.

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.